Saturday, February 7, 2015

Monetary aggregates - Narrow and Broad Money

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Nowadays, money doesn't just mean cash and coins you have with you. It also comprises deposits with the banking system or post offices, which you can convert to cash and coins as per your wish.

Now think about the liquidity feature of them. Clearly, cash and coins (currency) are the most liquid in nature, because, they could be used for your day-to-day transactions. But demand deposits (savings or current account deposits) in banks are less liquid than the currency. Similarly time deposits (fixed or recurring deposits) which have a maturity period associated with it, are even less liquid than demand deposits.

Monetary Aggregates
The Working Group on Money Supply, chaired by Dr. Y.V.Reddy (former RBI governor), set up to examine the analytical aspects of the monetary survey, introduced the new monetary aggregates -

M1 - It comprises all currency in circulation among public, and the demand deposits (savings and current account deposits) made by public in banks (including other deposits with RBI).

M2 - It comprises Savings deposits with Post Office savings banks, along with, all currency, and demand deposits with banks
(M2 = M1 + Savings deposits with Post Office savings banks)

Note that the monetary agrregates - M1 & M2 - are most liquid in nature, because currency will be with public, and demand deposits will be with banks, which you can easily encash by ATM, or drawing cheque, transacting through online, or using Point of Sale (POS) terminal, etc. This type of money is most liquid, but comprises a small part of total aggregate money, hence termed as Narrow Money

M3 - It comprises all currency with public and all demand and time (fixed and recurring) deposits with banks.
(M3 = M1 + Time deposits with banks)

M4 - It contains all currency with public, along with all demand and time deposits in banks, and it also includes all types of deposits (not only savings deposits) with Post Office. But it excludes National Savings Certificate (NSC).
(M4 = M3 + All deposits with Post office savings banks, excluding National Savings Certificates)

Note that, time deposits are not as liquid, or instantly available as demand deposits or currency, but will be available at certain time (on date of maturity), or you can convert it to cash by paying some penalty. Time deposits are much larger than M1 and M2 money aggregates. M3 and M4 are the total money available, hence known as Broad Money (note the meaning of 'narrow' and 'broad').

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